Barron's batters Fannie, Freddie, but boosts R.H. Donnelley; UnionBanCal up as it OKs sweetened bid

By Paul Deckelman

New York, Aug. 18 - Shares of Fannie Mae and Freddie Mac slid precipitously Monday after Barron's reported over the weekend that the Treasury Department was likely to move to recapitalize the struggling mortgage finance giants in the next few months - a step that would virtually wipe out existing equity holders.

At the same time, the magazine was touting R.H. Donnelley Corp. as a "risky but attractive way to bet on the continued profitability of publishing yellow pages," sending the Cary, N.C.-based telephone directory publisher's shares climbing robustly. Shares of sector peer Idearc Inc., which was also mentioned in the same article, were also up, although not as dramatically as Donnelley's.

Among companies with merger and acquisition news out, UnionBanCal Corp.'s shares shot up on the news that Japan's Mitsubishi UFJ Financial Group Inc. which already owns 65.4% of UnionBanCal, has agreed to buy the remainder at a sweetened offer price of $73.50 per share. Mitsubishi cancelled a tender offer for UnionBanCal shares that was to have begun Monday at the lower price that that the California bank had already rejected, and will slate a new tender at the higher price soon.

Electronic Arts Inc. said it would let its outstanding $25.74 per share tender offer for smaller rival Take-Two Interactive Software Inc. expire as scheduled at midnight without raising it - but far from giving up its pursuit of Take-Two, it has agreed to enter into talks with the other company that could eventually lead to a merger of the two video-game software companies on better terms.

Also in the software sector, Corel Corp.'s shares retreated for much of the session on the news that Corel Holdings, LP, an affiliate of private-equity firm Vector Capital Corp. that already owns 69% of Corel, withdrew its $11 per share offer to buy the remaining 31% of the company at $11 per share, preferring instead to allow Corel to explore other strategic alternatives. However, they ended slightly higher on the day.

On Wall Street, meanwhile, the bellwether Dow Jones Industrial Average fell 180.51 points, or 1.55%, to 11,479.39. Broader stock indicators also declined, with the Standard & Poor's 500 index down 19.60 points, or 1.51%, to 1,278.60, and the Nasdaq composite index off 35.54 points, or 1.45%, to 2,416.98.

Fannie, Freddie fall sharply

Government-sponsored enterprise mortgage giants Fannie Mae and Freddie Mac's shares were badly beaten down on negative investor reaction to a bearish piece that ran in Barron's, which said in a weekend piece that it was possibility is "growing increasingly likely" that Washington would step in to bail out the two GSEs sagging fortunes - but that any such rescue "almost certainly would wipe out" existing common shareholders.

The housing rescue bill passed last month by Congress and signed into law by president Bush contained a provision giving the Treasury Department wide powers to step in and stabilize Fannie and Freddie, which buy or back mortgages written by privately owned lenders, but which have lost billions of dollars since the sub-prime mortgage meltdown last summer metastasized into a steep slide in the larger lending industry. From now through next year, Treasury has wide powers to loan either or both of the GSE giants money if need be, or to buy stock in either or both if need be.

The Barron's article noted that, beset by mounting losses, Fannie and Freddie have been told by both the Treasury Department and their new regulator, the Federal Housing Finance Agency, to raise more equity - but "government officials don't expect the agencies to succeed" since they would need to raise at least $10 billion more apiece and "what common-stock investors would advance that kind of money to entities that have market capitalizations of $8.5 billion (Fannie) and $4 billion (Freddie), especially as the FHFA will use its new powers to boost dramatically the regulatory capital the GSEs must have in coming years?"

Faced with that dilemma, the administration "is likely to mount its own recapitalization, with Treasury infusing taxpayer money into the enterprises," Barron's said it was told by its source. "The infusion would take the form of a preferred stock with such seniority, dividend preference and convertibility rights that Fannie's and Freddie's existing common shares effectively would be wiped out, and their preferred shares left bereft of dividends."

A market source, meantime believes that the feds "will wait and see how they play out - but they won't stand for the mortgage market to become more dysfunctional than it is." He told Prospect News that Washington is holding off, for now, "looking for the banks to start retaining more of the loans they originated," rather than trying to palm them off on the beleaguered Fannie and Freddie. However, he opined, if the situation of one or both of them deteriorates much further, "it will come to the point that the feds will do a convertible preferred issue of some sort," completely gutting the positions of current shareholders.

Even though the Treasury said at mid-morning that it has "no plans" at present to use its newly granted authority to step in and backstop the two GSEs, the somber prospect that it might do so at some point down the line pushed Fannie Mae (NYSE: FNM) down $1.76, or 22.25%, to $6.15, on volume of 97.4 million shares, nearly double the norm, while Freddie Mac (NYSE: FRE) tumbled by $1.46, or 24.96%, to $4.39; volume of 92.8 million shares was also nearly double the usual turnover.

Donnelley dominates on Barron's boost

The weekend financial magazine was meanwhile also being credited with a solid rise in R.H. Donnelley, saying that the telephone directory publisher's shares had been so beaten down - having lost an eye-opening 97% for their value in the past year, going from $68 a share a year ago down to around $2 a share currently, with almost all of the carnage having taken place in calendar 2008 - that those beleaguered securities are "a risky but attractive way to bet on the continued profitability of publishing yellow pages."

The article did caution would-be investors that although Donnelley maintains impressive cash-flow generation despite a slowdown in advertising arising from the weak economy - it is expected to produce $475 million to $525 million in free cash flow this year - "the problem for equity investors is that none of that cash flow is heading directly to them. Instead, management is earmarking all its free cash for debt repayment." Net debt stands at some $9.7 billion, although none is due for repayment till 2010.

The article raised the possibility, being suggested by some in the market, that the company use a portion of its cash flow to buy back up to 25% of its stock in addition to paying down or buying back debt, which would restore investor confidence. Absent that, the article suggested, "an activist investor may also get involved."

With those possibilities at least floating around, even though management at this point is solidly committed to reducing debt and leverage with its free cash flow, the Barron's piece advised that assuming management's contention that the current slowdown in the company's ad revenues is merely a function of a weak economy rather than a fundamental weakness in its business model is correct - and company officials say its yellow pages remain popular and widely used out in heartland America - then "the stock could shoot up. And if it's not [the case], it probably will take another two years, at least, before its debt load sinks the company. That probability alone could be worth more than $2 a share."

Shareholders apparently agreed with that optimistic take, lifting Donnelley (NYSE: RHD) by as much as 28.1% in intraday action; the shares eventually came down from that peak to still finish up 31 cents, or 16.49%, at $2.19. Volume of 5.3 million shares was more than double the average daily turnover.

Sector peer Idearc (NYSE: IAR), affected by the same industry dynamics as Donnelley but seen as less able to generate free cash, according to Barron's, nonetheless got a boost along with Donnelley. Dallas-based Idearc's shares gained 7 cents, or 5.47%, to end at $1.35. Volume of 6.1 million shares was about 50% above normal levels.

Sweetened offer sweeps UnionBanCal higher

In M&A developments, UnionBanCal Corp.'s shares jumped on the news that the San Francisco-based banking company - already 65.4% owned by Mitsubishi UFJ Financial Group - agreed to a sweetened $3.5 billion/$73.50 per share bid by the Japanese financial powerhouse for the rest of the company.

Acceptance of that higher bid marked the culmination of four months of back-and-forth dealings between the two companies - Mitsubishi had originally offered $58 per share back in April, which UnionBanCal rejected as inadequate, and even after it upped that offer to $63 per share, UnionBanCal still said no. That caused the Japanese firm to raise its bid yet again, this time by another 17%, to $73.50.

UnionBanCal's board finally agreed to the new terms and will recommend that the company's shareholders accept the deal. Observers believe that once Mitsubishi completes its takeover of UnionBanCal, currently a Top 25 regional lender with over 300 branches in the western United States, it will be in a solid position to use its new acquisition as a base for making further inroads by acquisition in the U.S. banking industry. Unlike many other American regional banks, UnionBanCal has largely avoided the subprime mortgage meltdown that hurt those other lenders, making it an attractive acquisition target.

News of the deal boosted UnionBanCal (NYSE: UB) by $7.69, or 11.74%, to $73.18, just under the Mitsubishi bid. Volume of 34.8 million shares was almost 25 times the usual activity level.

CME gobbles up NYMEX

Also in the financial sector, members of the New York Mercantile Exchange okayed the acquisition of the exchange's parent company, NYMEX Holdings Inc., by CME Group Inc., which already owns the major commodities and futures trading exchanges in Chicago. Control of NYMEX will give CME a virtual monopoly on the trading in U.S. futures and options on futures.

CME's offer of $36 cash and 0.1323 of a CME share for each NYMEX share remained unchanged since the proposed deal was first announced in January - however, in that time, the total value of the deal declined sharply, to about $7.6 billion, from $11.3 billion originally, as CME shares declined by some 50%. Some NYMEX members grumbled that the offer undervalued their exchange and threatened to torpedo the arrangement, but after intense lobbying by CME, some 650 members, or about 80%, eventually went along with the takeover, well above the 75% threshold that was required. The deal is expected to close on Friday. Shares of both companies declined on Monday; NYMEX (NYSE: NMX) dipped $2.16, or 2.63%, to $79.95, on volume of 5.6 million shares, or 3 ½ times the norm, while CME (NYSE: CME) lost $21.03, or 5.88%, to close at $336.64, on volume of 1.5 million shares, about 20% more than usual.

Electronic Arts drops Take-Two bid - for now

Outside of the financial realm, Electronic Arts said it would spike its hostile takeover bid against rival software maker Take-Two Interactive Software, the maker of the wildly popular "Grand Theft Auto" series of video games - but it has by no means given up its hopes of acquiring New York-based Take-Two.

While Electronic Arts said that it would let its outstanding $25.74 per share tender offer for the other company expire as scheduled at midnight without raising it, effectively letting it die on the vine, the two companies agreed to continue talking.

Although Redwood City, Calif.-based Electronic Arts indicated that it now needs to "review the assumptions" behind its bid, since it will not be able to have Take-Two in its corporate fold in time for the all-important holiday selling and shipping season - a signal that it is threatening to pay less, rather than more for Take-Two - the latter said that it now expects to sign a confidentiality agreement with Electronic Arts that will let it share with Electronic Arts certain key non-public information about its operations, including its three-year product release schedule and management's financial projections. That Take-Two management presentation will be aimed at getting Electronic Arts to up the ante if it wants to acquire the company. Many observers believe that now that Electronic Arts has dropped its efforts to grab up Take-Two without the latter's consent, the two companies are more likely to agree to some kind of compromise.

Even so, Take-Two (Nasdaq: TTWO) dropped $1.09, or 4.39%, to $23.75 on volume of 4.5 million, more than three times the usual daily handle. Electronic Arts (Nasdaq: ERTS) was off 48 cents, or an even 1%, to $47.76, on volume of 3.6 million shares, about 20% less than usual.

Corel takeover cancelled

Another software firm seen trading around on M&A news was Corel Corp, whose shares retreated for most of the session before finally blipping upward at day's end. Investors reacted to the news that 69%-owner Corel Holdings, LP had withdrawn its $11 per share offer to buy the remaining 31% of the company at $11 per share. Corel Holdings is controlled by the private-equity firm Vector Capital Corp.

Ottawa-based Corel, maker of the widely used WordPerfect software program, said that a special committee formed to evaluate the holding company's proposal wound up identifying unspecified "third-party strategic alternatives" which it will now explore.

Corel (Nasdaq: CREL) initially plunged by 13% on news of the aborted buyout, but came off those lows and gradually moved back upward, finishing up 17 cents, or 1.80%, at $9.61, on volume of 65,000 shares, about four times the usual turnover.

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